I am the editor of The Energy Strategist and MLP Profits newsletters. I was previously a writer, editor and columnist at SmartMoney.com and before that a newspaper reporter and editor. Follow me on Twitter @IgorGreenwald or subscribe on Facebook at www.facebook.com/igor.greenwald

Obama Turns Back on Tax Fairness

“Everyone pays their fair share. Everyone does their part,” said President Obama after Congress extended most of the Bush tax cuts at the last minute.

Really?

Let’s look at the effect of the fiscal cliff deal on two hypothetical taxpayers representing large groups of real people.

Amy is a freelance graphic designer making $50,000 annually. Her Social Security tax has just risen by two percentage points, from 10.4% to 12.4%.

Ben is a business executive making $200,000 annually. His Social Security tax has just gone up by 1.1% of total income, maxing out at 6.2% of wages up to $113,700.

Anything above that cap is not subject to the Social Security tax. And Ben’s employer pays an equal share, while Amy is responsible for both the employee and employer portions.

The increase in the payroll tax will be the fiscal cliff’s sole effect on Ben’s and Amy’s tax burden. Amy will pay $5,726 in Social Security taxes this year. Ben, who will gross four times what Amy does, will pay $7,049, just like Warren Buffett.

Does that sound fair?

Not to Milton Friedman, who called the contribution scheme needlessly regressive as part of his attack on Social Security. That was in 1962. Since then, payroll taxes have only become much less equitable. As the rate kicking in with the first dollar of earned income has shot up, payroll levies have become a much bigger part of the total tax burden.

Ostensibly, the contribution is capped because so are the benefits, under a formula designed to make Social Security resemble a contribution pension scheme, even though it’s nothing of the sort.

Amy and Ben aren’t contributing toward their own Social Security benefits. Instead, they are funding the benefits already going out the door. And it’s not clear why this burden must be shouldered based on a benefits formula that may or may not apply down the line rather than their present means.

As a presidential candidate in 2007, Barack Obama initially supported doing away with a payroll tax cap. “Only 6% of Americans make more than $97,000—so 6% is not the middle class—it’s the upper class,” he said at a debate in Las Vegas. But Hillary Clinton accused him of advocating a trillion-dollar tax increase on “middle-class families” like those of firefighters and school supervisors, and so Obama eventually said additional payroll taxes only ought to be imposed on income above $250,000, the total he’d already promised to shield from higher taxes.

Of course, a position that proved controversial in the Democratic primary never had a chance in Congress. Nevertheless Obama revisited the cap hike in September while addressing a forum sponsored by the American Association of Retired Persons, minus pesky details. And then he went out and secured a regressive payroll tax hike for everyone.

The next time Obama returns to the subject will be, I imagine, in his memoirs. He’s a centrist and a pragmatist, after all, and plenty of Democrats from affluent blue states can’t stomach a 6.2% tax increase, be it on incomes above $113,700 or $250,000.

But the Congressional Research Service found in 2010 that doing away with the payroll tax cap would keep Social Security solvent for at least the next 75 years. Remember that the next time someone claims the only way to put things right is to curb benefits.

Correction: The Medicare tax is not subject to the income cap. All numbers in this post have been updated accordingly.

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I am amazed that Forbes published this article with so much ignorance and misinformation. Author correctly states that “the contribution is capped because so are the benefits”. But at the conclusion he recommends the option 3 at CBO link he provides. This option is stated as “Cover All Earnings and Pay No Additional Benefits”. This means that people over the current cap pay into social security but do not get any benefit. Even though I do not belong to this category of high earners, this is totally inequitable and against the philosophy of “Pay as you go” of social security. Social Security is not a welfare scheme, where you take money from rich and support the poor. For a truthful analysis, see: http://politicalcalculations.blogspot.com/2008/04/minimizing-risk-in-funding-social.html#.UOXEfqws3To This clearly explains that high incomes are so volatile, it will destabilize social security. Unless of course, you follow the option 3 above of taking money from high earners but not paying them back at retirement.

No kidding. Obama continues to take the money for all his vast expansionist social programs out of the hides of the middle class, because they are the easy targets and because the wealthy simply do not have enough money to do the job. The big cash cow is always in taxing the working middle class, and that number of people is shrinking daily. Fewer people are employed and paying taxes, and Mr. Obama happily keeps piling it on.

People accuse the Republicans of favoring the rich. They give tax breaks to the wealthy that are unwarranted, true. And they bloat up the deficit. Obama nails the middle class and bloats the deficit. Both philosophies are a disaster, but it is a myth to think Obama is somehow more “benevolent.”

Don’t forget, that 2% “tax holiday” he granted on the SS tax has to be repaid out of the money from the General Fund, and that means, you guessed it, increased taxes on the middle class to pay back their “holiday”.

YahooIsTOO INVASIVE, your comments are wrong! 1) Obama and Democrats forced top 1% to pay higher income tax of 39.6%. Marginal income and capital gains tax rates would increase relative to their 2012 levels for those with annual income over $400,000 for individuals and $450,000 for couples, but the rates below these levels would remain at their 2012 levels. The income rate would increase from 35% to 39.6%, and capital gains rate would increase from 15% to 20%. 2) Estate tax will increase to 40% from 35% for estates over $5 million. 3) A phase-out of tax deductions and credits for incomes over $250,000 for individuals and $300,000 for couples would be reinstated. 5) Bush tax cuts are permanent for income less than $400,000 for individuals and $450,000 for couples.

Obama had to compromise at payroll tax cut, Republicans wouldn’t give that to him. But all in all I think it was a pretty good deal for middle class. This is messy democracy, you win some, you lose some.

Igor, let me offer some contrary opinions. To the extent that a tax can be “fair” these are the fairest of all. Why? The people who expect to receive benefits are the ones actually _paying_ for them. What could be fairer than that? (Yes, I know the govt mishandles the money but that is a different problem.)

Contrast this with the so-called “progressive” approach where a modest minority of citizens pay taxes and the overwhelming majority receive benefits. That is the direction we are heading, the direction you want to head, and it is “unsustainable” — another leftist buzz word. Aside from that minor detail isn’t it objectionable for a capable adult to live at the expense of another? This whole business of expecting someone else to pay our way is – or ought to be – an affront to any self respecting person.

Igor, among other things, you should have mentioned that half of Amy’s social security tax is deductible, so the overall increase is less. I have been a freelancer for more than 30 years and so have considerable experience in this. Interesting choices are made when you have a mix of clients who pay 1099 and W-2. It does allow for some flexibility. This year I maxed my contribution and so allowed much of my W-2 pay to go on the last week’s time sheet so that some of my income above 110K would go to next year. This is to maximize my Social Security contribution for tax year 2012. As for Amy, like most freelancers these days, she probably has multiple clients and has a mix of payment types as I do. A couple of other things, if she does art for TV and other media, a portion of her cable bill is now a business expense. So is her internet connection as my guess is she does art electronically. So is her cell phone and many other expenses like a computer, software, more memory, camera, etc. She probably has to pay for her own health insurance. That is also deductible. So do not weep for Amy, or me for that matter. 1099/Schedule C work offers a lot of ways to cut your tax bill. Freelancing has some financial perks that make the tax bite a lot less painful. I can send you a sample if you wish. I’ve been audited twice, because we freelancers are audited frequently with both times passing and in fact I think I got a buck or two out of the last audit. Ulitmately though, your Amy example is no longer what you present it to be because you give the simplistic case without the real nuances. This makes your article, to politely put it. more than a bit misleading.

Great perspective, megagorgo. I also started working as S-corp from last year and I like the tax benefits we get. In fact the current trend is to hire people as contractors in IT industry, that way hiring company does not have to show contractors on its 10k.

Megagorgo, thanks for a very informative post. I find many posts to be irrelevant or worse. Yours brought some information that helps us better understand the issue. I wish that many other people posting comments could add to the debate with such insight! Thanks.

I found this article to be an incredibly misleading instigator of tension between classes that panders to an emotional characterization of the relative roles of middle-income workers (“Amy”) and executives (“Ben”) on the basis of “equity” while ignoring critical facts and the bigger picture of the nature of benefits and who truly shoulders the tax burden.

1) First: Medicare and social security are benefit plans where benefits out come from contributions. The contributions may be capped, but so are the benefits and the benefits not only come in exact proportion to the contributions (the strictest definition of equity) but higher-income individuals actually receive FEWER benefits in retirement for equivalent contributions due to programs like medicare means-testing.

To have a conversation about Tax (rather than benefit payouts from a contribution program) is an entirely different matter:

1) The top 1% of income earners have consistently paid 35-40% of the TOTAL tax burden (according to readily available tax data)

2) Even for lower income earners (Ben is not in the top 1%!) the share of tax Burden is skewed heavily against Ben’s favor. Assuming they are both single with only their salary income and living in California:

Amy will have an estimated federal and state tax liability of $7,395; whereas Ben will pay $62,259. (Based on federal tax calculator and CA Brackets.)

In short, Ben earns 4x’s as much as Amy but pays **8.4x’s** as much in income tax.

To focus only payments for limited benefits such as social security and medicare and then claim that Amy is paying more is incredibly misleading.

We can argue about whether or not Ben should shoulder more of the overall tax burden (perhaps he should) but it is not a matter of EQUITY. There is no doubt that the “upper class” pays SIGNIFICANTLY more.